The Elliot Wave Theory is a complex but highly effective method of analysing the movement of stock prices. It involves breaking down price trends into waves that move in a predictable and patterned manner, making it possible to identify potential turning points and trends with great accuracy. This article will explore some of the critical methods used by traders who employ the Elliot Wave Theory when trading stocks.
One of the fundamental principles of the Elliot Wave Theory is that price movement doesn’t move in a straight line but instead forms waves that move forward and then retrace before continuing again. These waves can be divided into five categories: impulse waves, corrective waves, zigzag corrections, flat corrections, and triangle formations. Each type of wave serves a specific purpose within the larger framework of price movement. One way to predict future movements is by studying how each wave ends – precisely in which direction it breaks following its completion (upward or downward). This information can give you valuable insight into what the next phase of price movement will look like.
The Fibonacci ratio is a mathematical sequence widely used in finance and trading because it frequently occurs in nature and the natural world. The series of numbers starts with 0 and 1, and then each number is equal to the sum of the two preceding ones: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34. Traders using the Elliot Wave Theory use these ratios to identify key turning points in price trends. For example, many analysts believe that when the price reaches one Fibonacci ratio level (such as 38%), there will be a corrective wave before prices increase again. Similarly, once prices reach another ratio level (such as 61%), they will begin to fall again.
One of the essential concepts in the Elliot Wave Theory is that price trends never move in a straight line but instead form wave patterns that move forward, retrace, and then continue. These waves can be grouped into two major categories: impulse and corrective waves.
Impulse waves follow an upward trend and are characterised by five distinct sub-waves. They are easy to spot because they typically exhibit a gradual incline with higher highs followed by lower highs. The goal of traders who use this method is to identify these impulse patterns so they can predict when prices are likely to change direction or level off – perhaps before reversals happen or during periods of consolidation.
In contrast to the impulse waves that follow a price trend upward, corrective waves move in the opposite direction. They are often formed after an impulse wave when prices begin moving downward and retrace some of their previous gains. As with impulse waves, there are five sub-waves within a corrective wave, though they tend to be more unpredictable than their counterpart because each wave can form into one of several patterns. Traders use this method to identify these patterns to predict future stock price movements accurately.
Another common type of corrective wave is the zigzag correction. As with impulse and corrective waves, zigzags form a pattern that moves forward before retracing gains or losses seen in previous waves. They consist of three sub-waves: an initial upward trend, a downward trend, and finally, another upward trend that can reach levels similar to those seen at the beginning of the pattern. Traders use this method to predict when prices might reverse direction – for example, after falling significantly following an upward trend.
Triangle patterns are another expected corrective wave that traders use to predict future price movements. Within the Elliot Wave Theory framework, there are two main types of triangle patterns: ascending and descending triangles.
As the name suggests, ascending triangles form when prices move steadily upward for a period and then consolidate within a symmetrical triangle pattern for some time before continuing their upward trend. Conversely, descending triangles form when prices begin moving downward from the point of consolidation and continue to fall gradually after forming the triangle shape.